Housing Bubbles and Speculative Buying Concern NAHB Economists

The good times will continue to roll in the housing market, but they won’t cruise along at quite the same pace as in 2005.

That was the general consensus of economists at the National Association of Home Builders (NAHB) 2005 Fall Construction Conference, held Oct. 19 in Washington, D.C. David Seiders, NAHB’s chief economist, is forecasting a decline in total housing starts from 2.032 million this year to 1.94 million in 2006, and a further drop to 1.883 million in 2007. After that, the annual production of new housing units (including manufactured homes) should settle around 2 million units, which is within the 1.9 million to 2.1 million rate that is sustainable on average for the 2003-2013 period, he said.

“We have been running a tad above that,” Seiders said, “but the comedown shouldn’t be all that dramatic.”

NAHB projects single-family construction to decline from 1.683 million starts this year to 1.590 million in 2006 and to 1.533 million starts in 2007. Multi-family output, however, should remain close to the 349,000 level expected for this year through 2007.

Buoyed by low mortgage rates and red-hot customer demand, the housing market again confounded the experts in 2005, beating forecasters’ estimates for 10 years in a row, according to Maury Harris, chief economist and managing director, USB Investment Banks, New York.

The housing market’s remarkable run over the past decade has raised a few red flags at the Federal Reserve Bank. Fed Chairman Alan Greenspan has said speculation and “exotic financing options” such as some of the new adjustable mortgages are fueling a housing bubble that can’t continue.

However, the economists at the NAHB Fall Construction Conference believe the market can maintain a more reasonable level of activity over the next few years. Their optimism is based in large part on some still-solid financial fundamentals. Mortgage rates are low, inflation is manageable and employment is healthy. David Wyss, chief economist, Standard and Poors, New York, said unemployment is at 5 percent and the rate of inflation, excluding food and energy, is at 2 percent.

“I would take 10 years like that right now,” he said. Wyss was most concerned about the potential of rising oil costs in the future. His concerns were fueled in part by the damage that the Gulf Coast storms did to oil refineries in Texas and Louisiana. He said because the United States has not built a new refinery since 1976, its capacity to refine oil was already stretched thin before the storms. While most of the refining capacity is back, 20 percent of the Gulf Coast refineries were knocked out by Hurricanes Katrina and Rita, he added.

Mark Zandi, chief economist, West Chester, Pa., Economy.com, has voiced his concerns about housing bubbles for several years. He said all of California and Florida are now overvalued, and that much of the Northeast Corridor, including Washington, D.C, and Boston, will be at risk in the next three years if housing prices in those markets continue increasing. Bernard Markstein, NAHB’s director of forecasting, said 50 percent of the nation’s housing stock is overvalued this year, up from 33 percent in 2004.

One measure of the current housing bubble is the ratio of median home price ($221,000) to median household income ($44,389). The current 5.0 ratio is the highest mark in 40 years, and several of the highest-priced markets are well over this ratio. According to the Harvard Joint Center for Housing Studies, San Diego (9.7), Los Angeles (9.1), Orange County (9.0) and New York (8.6) were the highest priced markets. On the flip side, Syracuse, N.Y. (2.2); Buffalo, N.Y. (2.2); Springfield, Ill., (2.2); Fort Wayne, Ind., (2.2); and Wichita, Kan., (2.0) were the least-expensive metropolitan markets. Zandi said without the “exotic adjustable-rate financing” now available, many people could not afford homes in these markets. He agreed with several other speakers that speculative buying is reaching alarming levels in some markets.

David Bergson, vice president and chief economist of Fannie Mae, Washington, D.C., said investors own 25 percent of the homes in some metropolitan areas, and that these markets are most at risk if prices suddenly dropped because of adverse economic conditions.

A key concern for home builders in the near future is rising material costs. They were hit hard over the past 18 months by double-digit increases in steel, gypsum, cement and some types of wood products. Michele Halickman, an economist who tracks construction materials costs for Global Insight, Washington, D.C., said relief is near. “Most commodities will come down in 2006,” she said. “We believe the worst is over. Believe it or not, it’s a normal business cycle.”

One notable exception is PVC pipe, which continues to suffer from the high cost of oil-based components needed in its manufacturing processes. PVC prices have increased 18 percent year-to-date in 2005, and are expected to climb 16 percent in 2006. Halickman doesn’t expect PVC prices to decrease until late-2006.

Over the next few years, the housing market will see a tremendous surge of rebuilding activity on the Gulf Coast in the aftermath of Hurricanes Katrina and Rita. An estimated 358,000 homes were destroyed and 900,000 homes were damaged, according to estimates by the Federal Emergency Management Association (FEMA) and the American Red Cross. That’s 12 times the amount of homes destroyed in Hurricane Andrew, the next most destructive storm on record.

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